The following discussion should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and related Notes and the Annual Report on Form 10-K for the year ended December 31, 2008.

Integrys Energy Group is a diversified energy holding company with regulated electric and natural gas utility operations (serving approximately 2.2 million customers in Illinois, Michigan, Minnesota, and Wisconsin), nonregulated energy operations, and an approximate 34% equity ownership interest in ATC (a federally regulated electric transmission company operating in Wisconsin, Michigan, Minnesota, and Illinois).

Strategic Overview

Integrys Energy Group's goal is to create long-term value for shareholders and customers through growth in its core regulated businesses. Integrys Energy Group is in the process of executing its previously announced strategy to divest of or significantly reduce the size of its nonregulated energy services business segment to a smaller segment with significantly reduced credit and collateral support requirements.

The essential components of Integrys Energy Group's business strategy are:

Maintaining and Growing a Strong Regulated Utility Base - A strong regulated utility base is essential to maintain a strong balance sheet, predictable cash flows, a desired risk profile, attractive dividends, and quality credit ratings. This is critical to Integrys Energy Group's success as a strategically focused regulated business. Integrys Energy Group believes the following projects have helped, or will help, maintain and grow its regulated utility base and meet its customers' needs:

† WPS's continued investment in environmental projects to improve air quality and meet the requirements set by environmental regulators. Capital projects to construct and/or upgrade equipment to meet or exceed required environmental standards are planned each year.

† Integrys Energy Group's approximate 34% ownership interest in ATC, a transmission company that has over $2.7 billion of transmission assets at September 30, 2009. Integrys Energy Group will continue to fund its share of the equity portion of future ATC growth. ATC plans to invest approximately $2.5 billion during the next ten years.

† Weston 4, a 537-megawatt coal-fired base-load power plant located near Wausau, Wisconsin, was completed and became operational June 30, 2008. WPS holds a 70% ownership interest in the Weston 4 power plant.

† A proposed accelerated annual investment in natural gas distribution facilities (replacement of cast iron mains) at PGL and proposed cost recovery mechanism.

† The investment of approximately $80 million to connect WPS's natural gas distribution system to the Guardian II natural gas pipeline completed in February 2009.

† WPS's purchase of the 99-megawatt Crane Creek wind generation project constructed in Howard County, Iowa, which is expected to be operational in the fourth quarter of 2009.

For more detailed information on Integrys Energy Group's capital expenditure program, see "Liquidity and Capital Resources, Capital Requirements."

Divest of or Significantly Reduce the Size and the Capital and Liquidity Commitments of the Nonregulated Energy Services Business Segment - Unprecedented energy price volatility, combined with significant growth in the forward contract portion of the business, has increased the collateral requirements of Integrys Energy Services at a time when global credit and financial market conditions are both constraining the availability and increasing the cost of capital. As a result, Integrys Energy Group has decided to divest of or significantly reduce the size of its nonregulated energy services business segment. In the event that a full divestiture of Integrys Energy Services does not occur and a portion of the nonregulated energy services business segment remains, it will be a smaller segment that requires significantly less capital, parental guarantees, and overall financial liquidity from Integrys Energy Group. Integrys Energy Group is committed to significantly reducing credit and collateral support requirements, with substantially all of this accomplished by the end of 2010. Integrys Energy Group is seeking to deploy its capital to areas with more desirable risk-adjusted rates of return. Although Integrys Energy Group anticipates a reduction in future earnings capacity from this business segment going forward, an improvement in the liquidity position, capital deployed, and reduced business risk profile of Integrys Energy Group is expected.

Integrating Resources to Provide Operational Excellence - Integrys Energy Group is committed to integrating resources of all its businesses, while meeting all applicable legal and regulatory requirements. This will provide the best value to customers and shareholders by leveraging the individual capabilities and expertise of each business and lowering costs. Integrys Energy Group believes the following recent developments have helped, or will help, integrate resources and provide operational excellence:

† IBS, a wholly owned service company of Integrys Energy Group, became operational on January 1, 2008. IBS was formed to achieve a significant portion of the cost synergies anticipated from the PEC merger through the consolidation and efficient delivery of various support services, and to provide more consistent and transparent allocation of costs throughout Integrys Energy Group and its subsidiaries.

† "Operational Excellence" initiatives were implemented to provide top performance in the areas of project management, process improvement, contract administration, and compliance in order to reduce costs and manage projects and activities within appropriate budgets, schedules, and regulations.

Placing Strong Emphasis on Asset and Risk Management - Integrys Energy Group's asset management strategy calls for the continuous assessment of existing assets, the acquisition of assets, and contractual commitments to obtain resources that complement its existing business and strategy. The goal is to provide the most efficient use of resources while maximizing return and maintaining an acceptable risk profile. This strategy focuses on the disposition of assets, including property, plant, and equipment and entire business units, which are no longer strategic to ongoing operations, are not performing as needed, or have an unacceptable risk profile. Integrys Energy Group maintains a portfolio approach to risk and earnings. Integrys Energy Group's decision regarding the future of Integrys Energy Services illustrates its asset management strategy.

Integrys Energy Group's risk management strategy includes the management of market, credit, and operational risks through the normal course of business. Forward purchases and sales of electric capacity, energy, natural gas, and other commodities allow for opportunities to secure prices in a volatile energy market. Each business unit manages the risk profile related to these instruments consistent with Integrys Energy Group's risk management policies, which are approved by the Board of Directors. The Corporate Risk Management Group, which reports through the Chief Financial Officer, provides corporate oversight.

Continuing Emphasis on Safe, Reliable, Competitively Priced, and Environmentally Sound Energy and Energy Related Services - Integrys Energy Group's mission is to provide customers with the best value in energy and energy related services. By effectively operating a mixed portfolio of generation assets and investing in new generation and natural gas distribution assets, while maintaining or

exceeding environmental standards, Integrys Energy Group is able to provide a safe, reliable, value-priced service to its customers. Integrys Energy Group concentrates its efforts on improving and operating efficiently in order to reduce costs and maintain a low risk profile. Integrys Energy Group actively evaluates opportunities for adding more renewable generation to provide additional environmentally sound energy to its portfolio. Integrys Energy Group believes the following activities have helped, and will continue to help, integrate resources to provide safe, reliable, competitively priced, and environmentally sound energy and energy related services:

† Managing operations to minimize the impact on the environment. WPS's Weston 4 facility, completed in 2008, is one of the most efficient pulverized coal-fired electric generation units in the country with state-of-the-art environmental controls, which allows reductions in the amount of emissions produced. Integrys Energy Group also expects to maintain or decrease the amount of greenhouse gases released over time and supports research and development initiatives that will enable further progress toward decreasing its carbon footprint.

† Effectively operating a mixed portfolio of generation assets and investing in new generation and distribution assets, such as Weston 4, wind projects, and its natural gas connection to the Guardian II pipeline, ensures continued reliability for Integrys Energy Group's customers.

                             RESULTS OF OPERATIONS

                           Three Months Ended              %              Nine Months Ended              %
                              September 30             Increase              September 30            Increase
(Millions, except per
share amounts)             2009           2008        (Decrease)          2009          2008        (Decrease)

Natural gas utility
operations              $    (19.9 )    $   (17.8 )          11.8 %    $   (197.1 )   $    48.5             N/A
Electric utility
operations                    38.3           51.6           (25.8 )%         88.3          78.6            12.3 %
Integrys Energy
Services' operations          23.8          (94.5 )           N/A             6.1         (33.9 )           N/A
Holding company and
other operations               8.9            1.6           456.3 %           8.3           7.6             9.2 %

Net income (loss)
attributed to
   common
shareholders            $     51.1      $   (59.1 )           N/A      $    (94.4 )   $   100.8             N/A

Basic earnings (loss)
per share               $     0.67      $   (0.77 )           N/A      $    (1.23 )   $    1.32             N/A
Diluted earnings
(loss) per share        $     0.66      $   (0.77 )           N/A      $    (1.23 )   $    1.31             N/A

Average shares of
common stock
   Basic                      76.8           76.7             0.1 %          76.8          76.5             0.4 %
   Diluted                    76.9           76.7             0.3 %          76.8          76.9            (0.1 )%

Financial Results - Third Quarter 2009 Compared with Third Quarter 2008

Integrys Energy Group recognized net income attributed to common shareholders of $51.1 million ($0.66 diluted earnings per share) for the quarter ended September 30, 2009, compared with a net loss attributed to common shareholders of $59.1 million ($0.77 net loss per share) for the quarter ended September 30, 2008. Significant factors impacting the $110.2 million increase in earnings were as follows (and are discussed in more detail thereafter):

† The net loss attributed to common shareholders at the regulated natural gas utility segment increased $2.1 million, from $17.8 million for the quarter ended September 30, 2008, to $19.9 million for the same quarter in 2009. The increase in the net loss was driven by a positive adjustment recognized in the third quarter of 2008 at MGU related to recovery of prior natural gas costs in an MPSC proceeding as well as lower quarter-over-quarter volumes, net of decoupling, attributed primarily to the general economic slowdown. The increase in the net loss was partially offset by the net positive impact that rate increases at MERC and MGU had on margin.

† Net income attributed to common shareholders at the regulated electric utility segment decreased $13.3 million, from $51.6 million for the quarter ended September 30, 2008, to $38.3 million for the same quarter in 2009. The decrease was driven by fuel and purchased power costs that were lower than what was recovered in rates during the third quarter of 2008, a decrease in sales volumes primarily due to colder quarter-over-quarter weather during the cooling season, and an increase in operating and maintenance expense, partially offset by higher margin from wholesale customers.

† Earnings at Integrys Energy Services increased $118.3 million, from a net loss attributed to common shareholders of $94.5 million for the quarter ended September 30, 2008, to net income attributed to common shareholders of $23.8 million for the same quarter in 2009. This increase was driven by a $113.8 million after-tax increase in Integrys Energy Services' margin quarter-over-quarter. The increase in margin was primarily related to the partial recovery of non-cash accounting losses related to derivative fair value and inventory valuation adjustments recorded in prior periods, an increase in realized wholesale electric margins, and an increase in realized natural gas margins.

† Earnings at the holding company and other segment increased $7.3 million, from $1.6 million for the quarter ended September 30, 2008, to $8.9 million for the same quarter in 2009, largely due to adjustments required by GAAP to the effective tax rate to ensure the year-to-date interim effective tax rate reflects the projected annual effective tax rate.

Financial Results - Nine Months 2009 Compared with Nine Months 2008

Integrys Energy Group recognized a net loss attributed to common shareholders of $94.4 million ($1.23 net loss per share) for the nine months ended September 30, 2009, compared with net income attributed to common shareholders of $100.8 million ($1.31 diluted earnings per share) for the same period in 2008. Significant factors impacting the $195.2 million decrease in earnings were as follows (and are discussed in more detail thereafter):

† Earnings at the regulated natural gas utility segment decreased $245.6 million, from net income attributed to common shareholders of $48.5 million for the nine months ended September 30, 2008, to a net loss attributed to common shareholders of $197.1 million for the same period in 2009. The net loss at the natural gas utility segment was driven by a $242.3 million increase in after-tax non-cash goodwill impairment losses period-over-period. Lower period-over-period volumes, net of decoupling, attributed to the general economic slowdown and warmer weather during the heating season, also negatively impacted earnings period-over-period. The decrease in earnings was partially offset by the net positive impact that increased rates at MERC, MGU, and PGL had on margin.

† Net income attributed to common shareholders at the regulated electric utility segment increased $9.7 million, from $78.6 million during the nine months ended September 30, 2008, to $88.3 million for the same period in 2009. The increase at the regulated electric utility segment was driven by an increase in wholesale margins, fuel and purchased power costs that were lower than what was recovered in rates during the nine months ended September 30, 2009 (compared with fuel and purchased power costs that were higher than what was recovered in rates during the same period in 2008), and a fuel surcharge increase effective July 4, 2008, a portion of which was incorporated into WPS's 2009 non-fuel base retail electric rates. The higher electric margins were partially offset by increases in maintenance expense, employee benefit costs, depreciation expense related to Weston 4, and interest expense.

† Earnings at Integrys Energy Services increased $40.0 million, from a net loss attributed to common shareholders of $33.9 million for the nine months ended September 30, 2008, to net income attributed to common shareholders of $6.1 million for the same period in 2009. This increase was driven by a $73.9 million after-tax increase in Integrys Energy Services' margin period-over-period. This increase in margin was primarily related to the partial recovery of non-cash accounting losses related to derivative fair value and inventory valuation adjustments recorded in prior periods and an increase in realized retail and wholesale electric margins, partially offset by restructuring expenses related to the previously announced strategy change, an increase in operating and maintenance expense, and an increase in the provision for income taxes related to discrete tax items.

Utility Operations

For the three and nine months ended September 30, 2009, and 2008, utility operations included the regulated natural gas utility segment, consisting of the natural gas operations of PGL, WPS, MERC, MGU, and NSG, and the regulated electric segment, consisting of the regulated electric operations of WPS and UPPCO.

Regulated Natural Gas Utility Segment Operations

                            Three Months Ended              %              Nine Months Ended             %
                               September 30             Increase             September 30             Increase
 (Millions, except
heating degree days)        2009           2008        (Decrease)         2009          2008         (Decrease)

Revenues                 $    211.6      $   315.2           (32.9 )%   $ 1,617.2     $ 2,091.5            (22.7 )%
Purchased natural gas
costs                          84.1          182.0           (53.8 )%     1,002.8       1,468.5            (31.7 )%
Margins                       127.5          133.2            (4.3 )%       614.4         623.0             (1.4 )%

Operating and
maintenance expense           112.2          112.1             0.1 %        390.1         391.2             (0.3 )%
Goodwill impairment
loss *                            -              -               - %        291.1           6.5          4,378.5 %
Depreciation and
amortization expense           26.4           28.1            (6.0 )%        78.8          80.6             (2.2 )%
Taxes other than
income taxes                    8.9            7.8            14.1 %         25.2          24.3              3.7 %

Operating income
(loss)                        (20.0 )        (14.8 )          35.1 %       (170.8 )       120.4              N/A

Miscellaneous income            1.0            1.0               - %          2.8           4.8            (41.7 )%
Interest expense              (12.6 )        (14.7 )         (14.3 )%       (38.8 )       (41.4 )           (6.3 )%
Other expense                 (11.6 )        (13.7 )         (15.3 )%       (36.0 )       (36.6 )           (1.6 )%

Income (loss) before
taxes                    $    (31.6 )    $   (28.5 )          10.9 %    $  (206.8 )   $    83.8              N/A

Throughput in therms
 Residential                   94.7           91.5             3.5 %      1,107.3       1,152.0             (3.9 )%
 Commercial and
industrial                     35.6           38.5            (7.5 )%       353.0         378.8             (6.8 )%
 Interruptible                  3.9            6.0           (35.0 )%        28.0          41.7            (32.9 )%
 Interdepartmental              3.5            5.8           (39.7 )%         7.9          24.2            (67.4 )%
 Transport                    248.1          296.2           (16.2 )%     1,157.6       1,320.1            (12.3 )%
 Total sales in therms        385.8          438.0           (11.9 )%     2,653.8       2,916.8             (9.0 )%

Weather
 Average heating
degree days                     134             96            39.6 %        4,573         4,597             (0.5 )%

* See Note 8, "Goodwill and Other Intangible Assets," for more information.

Third Quarter 2009 Compared with Third Quarter 2008

Revenues

Regulated natural gas utility segment revenue decreased $103.6 million, driven by:

· An approximate $92 million decrease in revenue as a result of an approximate 53% decrease in the average per-unit cost of natural gas sold by the regulated natural gas utilities in the third quarter of 2009, compared with the same quarter in 2008. For all of Integrys Energy Group's regulated natural gas utilities, prudently incurred natural gas commodity costs are passed directly through to customers in current rates.

· An approximate $12 million decrease in revenue as a result of lower quarter-over-quarter natural gas throughput volumes driven by:

- An approximate $9 million decrease related to lower residential customer volumes at WPS resulting from energy conservation efforts, and lower commercial and industrial customer volumes across all the natural gas utilities resulting from lower demand related to changes in plant operations, both of which Integrys Energy Group attributed to the general economic slowdown.

- An approximate $3 million decrease related to a reduction in volumes sold to the electric utility segment driven by the availability of lower cost power from MISO resulting in a decrease in the need for the electric utility to run its natural gas-fired peaking generation units.

· An approximate $2 million quarter-over-quarter decrease in revenue from the recovery of environmental cleanup expenditures at PGL and NSG related to former manufactured gas plant sites.

· The decrease in revenue was partially offset by the positive impact of natural gas distribution rate cases at MGU and MERC. Effective January 14, 2009, MGU received a final rate order from the MPSC for a natural gas distribution rate increase. On June 29, 2009, MERC received a final rate order granting a natural gas distribution rate increase. Prior to this final order, MERC had been granted interim rate relief effective October 1, 2008. Together, these rate increases had an approximate $5 million positive impact on revenue quarter-over-quarter. See Note 21, "Regulatory Environment," for more information on the rate increases at MGU and MERC.

Margins

The regulated natural gas utility segment margin decreased $5.7 million, driven by:

† An approximate $3 million quarter-over-quarter decrease in margin at MGU related to an adjustment in the third quarter of 2008 for recovery of prior natural gas costs in an MPSC proceeding.

† An 11.9% decrease in natural gas throughput volumes attributed primarily to the negative impact of the general economic slowdown, which resulted in an approximate $2 million decrease in natural gas utility segment margin. This quarter-over-quarter decrease in margin was tempered by the impact of decoupling mechanisms that were first effective for PGL and NSG on March 1, 2008, and for WPS on January 1, 2009. Under decoupling, these utilities are allowed to defer the difference between the actual and rate case authorized delivery charge components of margin from certain customers and adjust future rates in accordance with rules applicable to each jurisdiction.

† An approximate $2 million quarter-over-quarter decrease in margin due to lower recovery of environmental cleanup expenditures at PGL and NSG related to former manufactured gas plant sites. This decrease in margin was offset by a decrease in operating expense due to the amortization of the related regulatory asset and, therefore, had no impact on earnings.

† The decrease in margin was partially offset by a $1 million net positive quarter-over-quarter impact of rates, driven by rate increases at MERC and MGU. Lower fixed customer charges resulting from an approximate 1% decrease in customer base at PGL and a new rate design at WPS effective January 1, 2009, which incorporates higher volumetric rates and lower fixed customer charges, partially offset the rate increases.

Operating Loss

The operating loss at the regulated natural gas utility segment increased $5.2 million, driven by the $5.7 million decrease in natural gas margin, partially offset by a $0.5 million decrease in operating expenses.

The decrease in operating expenses quarter-over-quarter was the result of:

· An $8.0 million decrease in bad debt expense, primarily driven by PGL's and NSG's election under a new Illinois state law to file to recover from or refund to customers the difference between actual bad debt expense reported as a component of earnings and the bad debt expense included in utility rates retroactive to January 1, 2008.

· The decrease related to the reduction in bad debt expense was partially offset by:

- A combined $4.3 million increase in general and administrative salaries and employee benefit costs.

- A $1.9 million increase in natural gas maintenance costs, primarily related to increased system inspection and maintenance requirements.

- A $1.0 million increase in customer account expenses.

Other Expense

Other expense at the regulated natural gas utilities decreased $2.1 million, driven by a decrease in interest expense from lower quarter-over-quarter interest rates and lower average short-term borrowings, which resulted from lower natural gas prices and a decrease in capital expenditures. A decrease in interest expense paid on customer-related balances also contributed to the decrease in interest expense.

Nine Months 2009 Compared with Nine Months 2008

Revenues

Regulated natural gas utility segment revenue decreased $474.3 million, driven by:

· An approximate $392 million decrease in revenue as a result of an approximate 25% decrease in the average per-unit cost of natural gas sold by the regulated natural gas utilities during the nine months ended September 30, 2009, compared with the same period in 2008. For all of Integrys Energy Group's regulated natural gas utilities, prudently incurred natural gas commodity costs are passed directly through to customers in current rates.

· An approximate $106 million decrease in revenue as a result of lower period-over-period natural gas throughput volumes, driven by:

- An approximate $62 million decrease related to lower residential customer volumes resulting from energy conservation efforts, lower commercial and industrial customer volumes resulting from lower demand related to changes in plant operations, and a decrease in customer base at PGL, all of which Integrys Energy Group attributed to the general economic slowdown.

- An approximate $28 million decrease in revenue as a result of warmer weather during the heating season for the nine months ended September 30, 2009, compared with the same period in 2008.

- An approximate $16 million decrease related to a reduction in volumes sold to the electric utility segment driven by the availability of lower cost power from MISO resulting in a decrease in the need for the electric utility to run its natural gas-fired peaking generation units.

· An approximate $8 million period-over-period decrease in revenue from lower recovery of environmental cleanup expenditures at PGL and NSG related to former manufactured gas plant sites, partially offset by higher recovery of EEP expenses.

· The decrease in revenue was partially offset by the approximate $28 million period-over-period net positive impact of natural gas distribution rate cases and changes in rate design at the . . .